Halifax bank staff are accustomed to talk of redundancies. In 2004 the bank was considered a frontrunner to take over Abbey before Spanish bank Santander grabbed the UK's second-largest mortgage lender. With a huge overlap of branches, thousands of staff were considered vulnerable to the chop.

This week the prospect of branch closures and sell-offs will again fuel concerns about job cuts as Halifax Bank of Scotland's new owner, Lloyds Banking Group, considers how best to cope with the competing demands of a UK government keen to extricate itself from supporting banks and an EU commission eager to promote competition.

Lloyds is widely expected to give further details of plans to raise £25bn from shareholders and asset sales that should, if Chancellor Alistair Darling agrees, replace a planned government insurance scheme. While the taxpayer will retain a 43% stake in the bank, fears on the Lloyds board that ministers might have owned 60% would recede, and a delayed cost-cutting programme could get into full swing.

Sell-offs are expected to come in the shape of mortgage lender Cheltenham & Gloucester, internet-only banking arm Intelligent Finance and some branches in Scotland which Lloyds inherited from its purchase of the Trustee Savings Bank. Insurance businesses Scottish Widows and Clerical Medical could also be sold.

By 2011 Lloyds expects to tell shareholders that cuts have generated £1.5bn of savings a year. A Lloyds spokesman said staff reductions were not the chief target of the cuts programme. Top of the list was IT systems, and driving a harder bargain with what might loosely be called its "suppliers". But branch workers remain wary. "Staff are feeling very vulnerable at the moment," said Wendy Dunsmore, a national officer at Unite, the main banking union, adding that many staff saw worrying trends within the bank.

"There seems to be a cultural shift with much harsher management practices. For instance, we are dealing with a sharp rise in disciplinaries," she said.

This month the bank offloaded its Halifax estate agency business, putting at risk up to 460 jobs. In the summer the bank backed away from closing the C&G mortgage operation and shedding 1,600 jobs, but it has still cut 8,000 posts.

A shakeout of staff at Lloyds is expected to be replicated across the banking sector. Over the years several reports have highlighted how the UK is "over-banked". An industry grown fat on selling overpriced products of –in many cases – little benefit to anyone, propped up a massive branch network, free cash machines on every street corner and hundreds of thousands of staff (huge bonuses, another feature of the boom, tended to stay at board level and in the investment banking businesses).

But such reports were brushed aside by an industry that used its huge profits as leverage in the corridors of power.

In its recent report, the British Bankers Association (BBA) said the industry's benefits were manifold: "The banks' service to customers through 150m personal current and savings accounts, 3m small business accounts, 11m mortgages, 10,000 branches, 30,000 ATMs and a payments system processing £5tn of transactions annually demonstrates our fundamental support to everyone in the country."

Bank profits also reduced the country's balance of payments deficit and provided tax receipts by the bucket-load.

In the year before the financial crisis, financial services contributed £12.4bn in corporation tax (27% of the total) and £18.7bn in employees' PAYE – 15% of the total, according to the BBA. In 2008 the net exports of the UK financial sector, which spans banking, insurance, fund management, securities dealing and other financial services, peaked at £50.5bn. Of this, banks' earnings of £31.1bn constituted 62% of the total.

While these figures are unlikely to be repeated, politicians are now asking whether the UK should aim to recover lost ground and get back to business as usual, or redraw the banking landscape.

At every turn, there are strategic conflicts that tie policymakers in knots. On the one hand, the Treasury wants banks to resuscitate commercial and house purchase lending, and push up profits and employment. On the other, regulators insist that banks be circumspect when lending, keep piles of cash ready for a Northern Rock-style run, and mountains of capital in the form of blue-chip assets, which can be sold to cover rising debts.

Lending guided by the maxim "safety first" is hardly a recipe for a quick recovery in the country's fortunes. Adrian Coles, head of the Building Societies Association, warned that the contradictory aims of government and regulators were hurting building societies more than the banks, and inconsistent policies were making a bad situation worse.

Coles said: "There is a contradiction between the competing demands of a recovery in the economy and the safety of the banks. The regulator wants lenders to back mortgages with deposits as a key safety measure. Yet, we have an environment where there is no growth in net savings. Is it any wonder there is no new net mortgage lending?

"While some lenders may sell more, others will be forced to sell less because aggregate savings in the economy are unchanged," he said. "And building societies suffer more than the banks because competition in the market is distorted by the publicly owned bodies."

He points to the government's chief savings institution, National Savings & Investments, which recently increased the savings rates on some products by 1.5 percentage points. "In the market for Isas, Royal Bank of Scotland and Halifax have both been offering the most competitive deals," he said.

Coles said building societies would find it difficult to compete with Northern Rock in the new year, when it begins offering mortgage loans with £8bn of government funding. He welcomed a £20bn cap on savings deposits at Northern Rock imposed by the European commission, but was dismayed to find the Treasury had dug deep to support new lending with £8bn to add to the £4bn this year.

Building societies lost some 2,000 staff out of the 50,000 employed in 2007 as the sector shrank from 59 to 52 societies. Coles fears the squeeze on societies will allow banks to prosper at their expense.

The only route out of the crisis for building societies is to increase margins on mortgage lending. Increased margins will generate surpluses that can be ploughed back into table-topping products.

However, the contradictions in policy tear holes in the government's carefully constructed programme of expansion married to reform.

Privately, City analysts concede that bank and building society profits/surpluses will be generated at the expense of customers. With the taxpayer exhausted by the bank bailout, profits must come from higher margins on product sales. And with house sales at less than half the long-term average, the winners will be the better-capitalised banks and those able to raise funds from a wide range of sources.

Is it any wonder, then, that unofficial figures indicate that more than 80% of lending in the UK is by three banks – Barclays, Abbey and HSBC, with Barclays grabbing the lion's share.

Lloyds and RBS have a combined commitment to lend £27bn this year, though most of that will replace existing loans. Nationwide, the largest building society, has seen its market share of new mortgages cut despite raising funds on the wholesale markets to support its book of mortgages.

Yet even Barclays, HSBC, and Abbey's owner Santander, along with the state-owned banks, will struggle to generate the super-profits from retail banking they enjoyed in the boom.

The regulator has begun cracking down on products consumer groups have long put in the drawer marked "rip-off". Payment protection insurance, which covers monthly interest payments on credit cards and loans, once generated 10% of all retail banking profits. Before Barclays became a big player in investment banking, sales of PPI policies generated 10% of worldwide profits.

From 2004-2006, analysts at Credit Suisse reckoned Lloyds was earning more than 15% of its profits from sales of PPI policies on margins of more than 75%.

A three-year inquiry by the Office of Fair Trading, the Competition Commission and the Financial Services Authority has resulted in a collapse in sales, after the worst-offending products and supercharged sales techniques were ruled out of order.

Last week the FSA outlined how it planned to crack down on the sale of structured investment products, which commonly put a cap on investment gains in return for a "guarantee" against falls in asset prices. Many experts have derided the products, as well as the banks and financial advisers who still recommend them, after many failed to meet their guarantees. This year the FSA has shut three sales operations.

Hargreaves Lansdown, the UK's largest independent financial adviser, said the FSA's decision would prove a disaster for financial services and especially banks. It said: "They have shovelled these products since the dotcom market collapse in 2000. Between the banks and the IFAs, the cost must run into the billions of pounds."

A smaller, less profitable retail banking sector will fundamentally alter the economics of Britain's financial services. Much of the wheeling and dealing done by UK banks on the international stage – such as lending to Chinese businesses and brokering debt raising in Africa – was supported by booming and supposedly solid retail deposits and mortgage assets.

Critics of the banking industry, including the Liberal Democrat treasury spokesman Vince Cable, argue that stopping reckless dealmaking will benefit the UK economy. Never again will the banks put at risk tens of billions of taxpayer funds. But millions were hooked on the benefits and a severe detox could cause havoc. Banks even filled charity coffers more than any other sector in corporate Britain. Lloyds plans to cut its donation from 1% of profits to 0.5%, denying charities £22m.

Angela Knight, head of the BBA, says the aims of the government and the regulator, while laudable in the longer term, are stifling the ability of banks to be part of the solution, and to repair some of the economic damage that they caused. "If government starts applying too many reforms now, it means tying up more capital at a time when it is needed to boost credit and lending," she said.

"Banks have already doubled the amount of capital they hold, which is probably the most pro-cyclical thing we could have down when most people agree we need to institute counter-cyclical measures to prevent a repeat of the crisis."

Corporation tax receipts have declined from a high of £12bn to an estimated £7bn this year. Mortgage approvals have slumped from about 130,000 a month in 2007 to nearer 56,000. Loans to businesses are already down. Between January and June, lending fell by £18bn at Lloyds and by £7bn at RBS.

The regulator will produce an impact assessment of its reforms before it forces the banks to comply, but in the meantime, those who gained from the banks' largesse will be in for a rough ride.